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Updated on Feb 20, 2008 10:20 PM IST
India should focus on going where China cannot go, rather than focusing where it has already been, writes Daniel H Rosen.
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None | ByDaniel H Rosen

India has moved up to Division A in the world economy with three consecutive years of 8 per cent-plus growth. Both Indians and foreigners will benchmark the country’s economic performance not against the past, but against the leading emerging markets, foremost of which is China. On the World Bank’s business environment indicators for 2008, India moved up 12 places in the ‘Doing Business’ category, 26 places in ‘Getting Credit’, and a stunning 63 places in ‘Cross Border Trade’. Many in China debate whether they have underestimated India’s competitive potential. Are we overestimating how much India has to learn from China?

If it sometimes seems incredible that China can grow so quickly without creating weak links in the economic chain, it isn’t true — there are many weak links. The problems can be seen both structurally, in the model of China’s approach to development and in the marketplace where firms compete. Economic output is the product of a mix of inputs: land and resources, labour and capital. A country’s natural endowment of these inputs and the efficiency with which businesses mix them together determine its competitiveness. In terms of useful land, China is not well endowed relative to its population size and the productive value of what land there is has declined significantly as a result of the choice to keep production costs low at the price of a future environmental crisis. Environmental costs are already starting to push up China’s operating costs noticeably. Impressive Chinese manufacturing competitiveness looks less impressive once you take basic environmental compliance into account. In terms of natural resources, China is well endowed only with coal. In terms of everything else, China’s input costs are as high as — or higher than — everyone else’s. This certainly goes for usable water too.

In terms of capital, it might seem at first glance that China is well endowed. But for the economy as a whole it is not just sheer volume of household savings, foreign exchange reserves and net profits at protected State-owned companies that count, but whether the financial intermediation system is any good at getting that capital to the firms that can use it best. On this score, China is in a sad shape. Financial flows build up overcapacity in some sectors and undercapacity in others, while households suffer from negative real deposit rates for the use of their $ 2.3 trillion in life savings. Pensions and healthcare are not provisioned. Liabilities at the banks have had to be bailed out time after time. And once the current profit cycle turns down — after all, China has business cycles like the rest of us — a new wave of non-performing loans is likely to arise.

It is obvious that China is richly endowed with a labour force. Now, whether it is utilised efficiently is another question. Unskilled labour was so abundant in the past that many manufacturers chose archaic modes of making stuff rather than invest in technology and innovation. That choice has brought its own problems, as many manufacturers are finding it hard to compete in the face of even moderate wage inflation. But moreover, by directing the bulk of investment into heavy industry instead of labour-intensive light industry and services, China is not growing according to its best advantages. The five biggest energy users in China — steel, cement, aluminum, glass and chemicals — employ fewer people today than they did ten years ago, and fewer people than the service sector in Guangdong province alone. China’s labour advantage simply doesn’t accrue to most of the best known Chinese firms.

Lax intellectual property rights protection has created an economy with a questionable ability to deliver real hi-tech innovation close to the frontier. Much of what passes for hi-tech in China is actually a modest adaptation of existing technology, often involving piracy. Where more significant innovation is taking place, it is usually owned and operated by foreign enterprises. This is good for China, no doubt. But it is not the same thing as booming indigenous innovation. The lack of a regulatory culture produces weak quality controls, which has made building Chinese brands difficult. Concerns about lax products standards have lately tarnished Brand China itself.

Corporate governance remains merely an aspiration. Shareholders have no illusion that managers of their firms will fulfil a fiduciary duty to deliver maximum shareholder value: the prevailing philosophy of investing not being a fundamental value but insider trading (with numerology being popular one too).

Generally, the home-court bias against individual rights (like rules against class action lawsuits over product defects) and in favour of corporate interests has ill-prepared Chinese firms to be ‘customer-facing’ downstream from the manufacturing process alongside firms accustomed to operating where the consumer is king. This partly explains why despite their manufacturing prowess, most Chinese firms leave the lion’s share of profit margins to foreign distributors and retailers. This could change over time, but it will likely be a decade or more before Chinese policy favours consumer welfare over producer welfare.

The fact that China has weaknesses doesn’t make the comparative advantages for India obvious. It does suggest where the path of least resistance lies. Even based on a casual appraisal one can see areas where India is positioned to build its international position. India has achieved high recent growth despite a daunting array of infrastructure failings, low economies of scale in production, bureaucratic delays and political frictions. If India can grow with such burdens, then growth should be accelerated with relatively straightforward reforms.

With labour pressures mounting in China, international marketspace previously saturated with Chinese output is starting to open up. Factories are decamping from Guangdong and Xiamen to Vietnam and the Caribbean. India can be a giant part of this story. Textiles and apparel have been China’s staple. But they were Britain’s, America’s, Japan’s and South Korea’s in succession until they fell pray to the same wage inflation China faces today. In more capital intensive production as well, China’s factor endowments are no better than India’s. A multitude of factors are combining to encourage Chinese firms to migrate to Brazil and Saudi Arabia so as to be closer to raw materials. Importantly, by avoiding the trap of industrial sector over-development that China has fallen into, India can continue to enjoy high international prices for its iron ores, avoid future environmental clean-up costs, dodge some of the producer price inflation China now faces, mitigate (though not eliminate) energy security anxieties, and lessen the impact a post-Kyoto climate agreement would have on economic growth.

Corporate interests masquerading as nationalism have tempted Beijing to block several inward foreign investments recently. In 2008, India may surpass China in terms of foreign investment as a share of total investment: the annual current flow of $ 15 billion could be doubled or tripled in the years ahead if India demonstrates that its pro-growth policy is here to stay. China passed the $ 15 billion mark in 1992 and by 1993 was at $ 39 billion, by 1996 $ 55 billion.

India can focus on going where China cannot go, rather than focusing where it has already been (read: heavy industry). Upstream from manufacturing lies innovation, which weak intellectual property protection makes difficult in China. And downstream lie high-value, customer-facing businesses that Chinese firms have major trouble developing. The heavy industry that so mesmerises Beijing creates pollution, not jobs. It would be a pyrrhic victory to beat China at this game, even if India could.

These are just a few of the opportunities for honing India’s competitiveness vis-à-vis China today. As China grapples with adjusting its growth model this year in light of serious inflation, a stock market correction, continued exchange rate appreciation and rapidly rising production costs, India will no doubt identify other chances to improve competitiveness as well. The key will be to learn not just from what China does best, but from what it does less well too.

Daniel Rosen is a Visiting Fellow at the Peterson Institute for International Economics in Washington DC. He is also an Adjunct Professor at Columbia University.

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